Via Bill Evans at Westpac:
As expected the Reserve Bank Board decided to cut the cash rate target from 0.25% to 0.1%; cut the target yield on the 3 year bond from 0.25% to “around” 0.1%; cut the rate on new drawings under the Term Funding Facility from 0.25% to 0.1%; and cut the rate Exchange Settlement balances from 0.1% to zero.
A five year yield target was considered but five years was considered to be too far out to be confident that rates would not be increased over the period.
The Board has also committed to purchases of government bonds of maturities of around 5 to 10 years over the next six months. Those purchases will be issued by the Australian Government and the states and territories with an expected 80/20 split. The bonds will be bought in the secondary market through regular auctions with weekly purchases of around $ 5 billion.
The Governor indicated the RBA had not ruled out buying bonds outside that maturity spectrum.
The Governor confirmed the objective of lowering the Australian dollar through a lower long term bond rate – dissuading foreign investors of purchasing AGS with reducing a resulting upward pressure on the exchange rate.
Purchases of AGS will be conducted on Mondays (5 to 7 years); and Thursdays (7 to 10 years) while semi purchases will be conducted on Wednesdays.
The size of the initial purchases of AGS will be around $2 billion and $1 billion for the semi’s.
In addition, the Bank is prepared to purchase bonds in whatever quantity is required to achieve the 3 year yield target. These purchases will not form part of the $100 billion program.
Market Consensus was a purchase program of $100 billion (across all maturities) so by complementing that $100 billion with the 3 year open ended program this announcement represents a more aggressive approach than expected, in particular restricting the $100 billion to the longer term maturities.
The Governor indicated that the choice of $100 billion (5% of GDP) was based on observations of other central banks where around 5% of GDP had a meaningful impact on markets and policy objectives.
While we respected market Consensus our preferred approach would have been to retain more flexibility so it is not surprising that this announcement has lowered bond rates.
The Board will “keep the size of the bond purchase program under review and “is prepared to do more if necessary”.
As we have discussed in earlier notes this Consensus view of the likely bond purchase program would see the RBA’s balance sheet increase to around $550 billion – $ 300 billion currently plus, say, $140 billion for the TFF (entities have access to a further $104 billion and the facility may increase before final drawdown in June 2021) plus $100 billion in the new facility. In addition, we should allocate some balance sheet to defend the 3 year bond rate target of 0.1% (say $10 billion).
That would lift the balance sheet to, say, $550 billion or 27.5% of GDP. That growth will see the RBA increasing its balance sheet which was $180 billion before COVID by a stunning 300%.
In contrast the Federal Reserve has increased its balance sheet since COVID from $3.8 trillion to $7.05 trillion – an increase of 85%. The FED’s balance sheet is now around 33% of GDP.
The RBA will be very rapidly closing in on the FED from a “standing start”!
We had been concerned about the issue for the RBA of setting a price (the three year bond rate target) and a quantity. The RBA has neatly got around that issue by restricting the purchase program to the 5 year plus maturity part of the curve and leaving the volume of purchases necessary to achieve the three year target open ended.
The decision to set the rate on Exchange Settlement balances at zero is a surprise. Arguably, Consensus was that the rate would be set at five basis points to ensure that short term private rates remained positive. Our view was that it was likely to be set at one basis point. We speculated that such a decision would open up the possibility of negative short term (not policy) rates since banks would not be motivated to take wholesale deposits at positive rates if the alternative use of the funds was ESA investment at one basis point.
Under a zero ESA rate the decision to offer a positive deposit rate will be even more difficult. Of course, banks will need to weigh that issue against long term relationships.
However, the Governor confirmed the Board’s view that a negative policy rate is “extraordinarily unlikely” – the main issue being the impact of negative rates on the supply of credit.
The most likely reason why this might change is if “the biggest central banks in the world” went negative – presumably that means the Federal Reserve given that the ECB and BOJ are already negative.
The Governor has also released the Bank’s revised forecasts for growth; unemployment; and inflation.
Last week we forecast that the RBA would revise down their forecast for the unemployment rate from 10% by December to 8% and to 6.5% by end 2022.
The Governor announced that the forecast is now just below 8% in December 2020 and 6% by end 2022 – slightly more optimistic than we had anticipated.
We expected that the RBA’s GDP growth forecast for 2020; 2021; and 2022 would be –4%;3.5%; and 3.75%.
The Governor announced growth forecasts of 6% (year to June 2021) and 4% (year to June 2022). Our -4% estimate for 2020 implies an assumption of around 3.5% growth in 2020 H2 and we expected around a 2% assumption for 2021 H1 meaning around 5.5% for June 2021 – a little lower than the Governor’s 6% forecast.
Our forecasts would have implied a June 2022 growth rate of 3.5%, once again slightly lower than the RBA’s forecast.
The Bank’s inflation forecasts are in line with general expectations.
Conclusion
These moves are more aggressive than we had expected and the Governor has certainly left open the possibility for further QE.
On the other hand, while the decision on the ESA zero rate opens up the possibility of negative short term private rates a choice of a negative policy rate is still “extraordinarily unlikely”.
This analysis has been based on the official Statement from the Governor and his one hour press conference.
And Gareth Aird at CBA:
The decision
Expectations were high today that the RBA would announce a suite of measures to ease financial conditions and the central bank duly delivered. There were a number of key elements to the package announced today:
■ A reduction in the cash rate target to 10 basis points (from 25 basis points).
■ A reduction in the target for the yield on 3‑year ACGBs to “around “10 basis points (from “around” 25 basis points).
■ A reduction in the interest rate charged on the Term Funding Facility (TFF) to 10 basis points (from 25 basis points).
■ A reduction in the interest rate paid on exchange settlement balances at the RBA to 0 basis points (from 10 basis points).
■ A commitment to purchase $A100bn (which is approx.5% of GDP) of ACGBs and Semi‑government securities (with an expected 80/20 split) of maturities of around 5‑10 years over the next six months. On interest rates
Lowering the cash rate target, the target on the 3‑year Australian Government bond yield and reducing the term funding facility rate all to 10 basis points was expected by the market, and us.
The interest rate cuts are designed to reduce the short term interest rates faced by households, businesses and by extension government. Lower interest rates assist indebted households and businesses to repay their loans by reducing the interest cost on the debt. In addition a further reduction in short term interest rates should, at the margin, encourage more new lending than would otherwise be the case. Lower interest rates also impact the exchange rate (more on that below) and support asset prices.
It is true that we are talking about very small changes to interest rates in basis point terms (albeit that in percentage terms the changes are significant). But the objective behind the decision to lower interest rates is the same as it has always has been – to influence economic activity and support aggregate demand.
In the short run the evidence is clear that lower interest rates have a positive lagged impact on economic activity and inflation. But lowering interest rates is not a long term solution to economic prosperity.
Regular readers will be aware that we have continued to question the efficacy of pushing key policy rates lower from here. There is an abundance of liquidity in the system and the actual cash rate has been trading below the previous 25 basis points target at 13‑14 basis points. The actual cash rate is likely to now drop to 0.5 to 2 basis points because of the fact the RBA will now pay zero on retail bank’s cash balances held at the Reserve Bank (known as exchange settlement accounts or ES accounts). There is a substantial risk that one month and three month Bank Bill Swap Rates (BBSW) set negative in coming days and regularly in the period ahead.
The interest rate sensitive parts of the economy, particularly the housing market, have already been responding positively to incredibly low interest rates. Any further reduction in mortgage rates that follow from today’s decision will put further upward pressure on dwelling prices. Indeed dwelling prices could accelerate quite quickly as the economic recovery continues to gain traction.
Today’s decision to lower policy rates will be the last time the RBA drops short term interest rates unless there is a radical change of view and the central bank seeks to go down the path of negative interest rates. We continue to consider that unlikely.
Asset purchase program
The decision today to introduce a program to purchase longer‑dated government bonds brings the RBA into alignment with what many other central banks have been doing around the world for some time now. We expected the RBA to announce a fixed quantity of $A100bn of government bonds of maturities of around 5 to 10 years and that’s exactly what they delivered.
We did not expect the RBA to announce a fixed time frame for the bond purchases, although we did state that we thought they would purchase bonds at a pace of around $A15bn a month, which would see purchases total $A100bn by the middle of next year. A back of the envelope calculation means that the RBA will be buying bonds at a slightly more aggressive pace than that. The intention to purchase $A100bn of bonds over a six month period works out at a pace of $A5bn a week (with a break over the Christmas‑New Year period).
The objective behind the asset purchase program is to lower longer dated bond yields and specifically the spread between Australian government bond yields and bond yields offshore. That in turn puts downward pressure on the Australian dollar. The AUD has eased over the past two months and is currently buying $US0.7032 (it is slightly lower on where is was trading just before 2.30pm which will satisfy the RBA).
It is worth noting that any shorter dated bonds purchased to support the new target yield on the 3yr Government bond will be in addition to the $A100bn bond purchase program.
The outlook
Today’s significant RBA monetary policy easing should not be conflated with a deterioration in the outlook for the Australian economy. In fact it is quite the contrary. The domestic economic outlook has improved over recent months and the RBA will upwardly revise its profile for GDP in the November Statement on Monetary Policy (SMP), which is published on Friday (6/11). By extension the RBA will downwardly revise its profile for the unemployment rate. These forecast revisions largely reflect a run of better than expected economic data (actual outcomes) and ongoing improvement in many of the forward looking indicators of the economy.
We expect GDP growth of ~4% in H2 20 and on our forecasts the unemployment rate peaked at 7.5% in July 2020. In today’s Statement the Governor noted that the RBA expect the unemployment rate to peak at a little below 8%. We expect the unemployment rate to be 6½% by end 2020.
Restrictions on activity continue to be lifted, most notably in Victoria, and this will support the domestic economic recovery and in particular a recovery in spending and employment. Australian households have accrued huge buffers of savings that will support consumption over the period ahead and consumer confidence is comfortably above its pre‑COVID‑19 levels.
It is highly unusual for the RBA to ease policy when the economic outlook is improving. But these are unusual times. The RBA’s updated forecasts on Friday will indicate that they expect the economy to have elevated spare capacity over the forecast horizon (end 2022). And they will continue to forecast below target underlying inflation over their forecast horizon. On that basis today’s easing is justified.
RBA policy will now remain on hold at least until Q2 2021 when the asset purchase program ends. Further policy easing beyond that cannot be ruled out, but this will depend on the economic conditions and outlook at the time.
